Australia: Serious misconduct: executive loses $7 million pay-out

Serious misconduct discovered after termination can be
used to justify summary dismissal and may result in the employer
justifiably withholding certain statutory and contractual
entitlements.

A recent decision by the NSW Court of Appeal's decision is a
timely reminder that employees, particularly those in executive
positions, must fulfil their contractual and statutory obligations.
Failure to do so may amount to serious misconduct, entitling the
employer to dismiss the employee summarily and potentially
withholding contractual entitlements, including bonuses.

In Downer EDI Limited v Gillies [2012] NSWCA 333, the Court of
Appeal overturned a decision by the Supreme Court which saw a
former executive awarded more than $7 million in damages. President
Allsop (with whom Justices Macfarlan and Meagher agreed), found the
former executive had engaged in serious misconduct when he, albeit
with honest intentions, borrowed or "advanced" money from
his accrued bonus account without notifying the board, not taking
into account tax obligations, and without regard to the
reputational risks to which he was exposing his employer.

The executive's employment

Stephen Gillies was employed by Downer EDI Ltd in 1988 until his
termination in 2007. For the last 10 years of his employment,
Gillies held the positions of managing director and chief executive
officer.

Over the years, Gillies was considered to be a most valued
employee, whom the Board had relied on to build the business into a
multi-billion dollar enterprise.

He was given certain entitlements within this position by way of
his contract of employment. These included a bonus plan, capped at
50 percent of his annual salary ($1.5 million at the time of his
termination), as an additional benefit under the executive share
option plan. These share options were available to Gillies up until
2000. After this time, the Phantom Option Scheme
(POS) was introduced which gave the managing
director all of the benefits available under the share option plan
without issuing of shares or options (which dispensed with the
requirement to report the arrangement to the ASX and
shareholders).

The bonus Gillies was entitled to was announced each year. These
bonuses accrued over time as Gillies opted to delay drawing on them
– a decision seemingly based on tax considerations.

In August 2007, following a downturn in profits, the board
passed a no-confidence motion on Gillies, who was stood down from
his position, and ultimately dismissed.

Downer later relied on alleged misconduct to justify the
dismissal, although the evidence of misconduct was discovered after
Gillies had left its employment.

Alleged misconduct

The alleged misconduct regarded money which Gillies borrowed, or
"advanced", against his accrued bonus. It was accepted
that in 2002 Gillies and Downer's chief financial officer
arranged for two payments of $450,000 and then $1.2 million to be
transferred to Gillies to allow him to buy a boat. Gillies viewed
these payments as advances on his bonus, which did not need to be
repaid (although he did pay back the amounts), while the CFO viewed
these payments as loans taken from the bonus account. The problem
was that these transactions were not board approved, the second
payment overdrew the bonus account by $200,000, and Downer was left
with an unfunded tax liability.

The second incident which allegedly amounted to misconduct
related to a number of transactions in 2006 and 2007 totalling over
$750,000 which allowed Gillies to purchase a property in New
Zealand. He arranged through the CFO (who by then had been
appointed as finance director) for deposits to be made in New
Zealand currency into Gillies' New Zealand account. There were
understood to be withdrawals from his bonus account. He
subsequently drew cheques for the amounts in Australian currency,
which were understood to be repayments to his bonus account. The
Court of Appeal described the arrangement as a "short term
unsecured loan in foreign currency".

Although the finance director claimed that there was a practice
of allowing senior employees to utilise Downer's "treasury
function" for private reasons, there was no evidence of this
practice.

Whether Gillies had engaged in serious misconduct had
significant monetary impact, as the contract stated that the
termination payments (which included three months' notice and
bonuses) "will not be payable in any case where the
termination is effected under Clause 4.1(c) due to your misconduct
or fraudulent activity."

Supreme Court decision

There were a number of issues before the Supreme Court, which
were later taken up on appeal. Relevantly, the court had to
determine:

was the POS ratified, and was it binding and effective;

when did the employment relationship between Downer and Gillies
come to an end;

if the POS was binding and effective, was Gillies employed when
he made his election to withdraw all money from the bonus account
(the answer to which flowed from the second question);

did Gillies engage in serious misconduct during his employment,
such that by clause 4.3 of the contract or the general law, he had
no right to the termination payment; and

was Gillies indebted to Downer in respect of a loan for a
car?

Justice Rothman ultimately found in favour of Gillies on all
accounts.

He found that the POS was incorporated as part of Gillies'
contract and, importantly, that the alleged misconduct was not
dishonest, improper or inappropriate – Gillies "did not
exploit his position as CEO for personal gain at the detriment of
the shareholders."

Decision on appeal

The five questions outlined above were put to the Court of
Appeal, which unanimously found in favour of Gillies on four of
those but, importantly, it found that he did engage in serious
misconduct during his employment, and as such was not entitled to
the termination payment (calculated to be in excess of $7
million).

It found that Gillies' conduct was incompatible with due and
faithful discharge of his duties as the most senior executive in
the company, judged within the legal framework in the Corporations
Act.

The court found that:

"Gillies was obliged to exercise his powers and discharge
his duties with a reasonable degree of care and diligence in
Downer's circumstances (s 180), in good faith (including
honestly) in the best interests of Downer and for a proper purpose
(s 181), and he was obliged not to use his position improperly to
gain an advantage for himself or to cause detriment to Downer (s
182). Further, by his position as a director of a public company,
Mr Gillies was a related party of Downer (s 228). As such, for
Downer to give Mr Gillies a financial benefit (as described in s
229), unless the benefit was remuneration (s 211) or the amount was
below that prescribed by regulation, being $5,000 (s 213), the
approval of Downer's members was required."

The conduct had to be assessed objectively, and although honesty
and motive may be relevant, Gillies' understanding of his
justification for being paid large sums of money by Downer was
"entirely lacking in proper justification". This was
particularly so where Gillies took no steps to acquaint himself
with the basis of his entitlement, or indeed what amount he was
entitled to.

The court found that Gillies' use of his position was
objectively improper as it related to the boat payments as well as
the New Zealand currency transaction:

there was an improper use of Downer's funds (albeit with an
assumed claim of right);

the funds were for personal use; and

the transactions exposed Downer to risk of damage and
contravention of tax and corporations legislation (even if Downer
did not sustain a financial loss due to the transactions).

Gillies had further submitted that even if he had engaged in
serious misconduct, his termination was not
effected because of that conduct, and as such, he
was entitled to the termination payments. The Court of Appeal,
however, enforced the long-standing common law principle that a
contracting party is not deprived of a justification which existed
for a contractual position, whether it was known at the time or
not. It held the use of the word "effected" includes
effected as a matter of law, and is broader than the historical
fact of what occurred.

As such, given the wording of the contract, the court found that
Gillies was not entitled to the termination payments.

Implications

The Court of Appeal's decision reinforces that:

executive employees may have contractual, statutory, and
possibly fiduciary obligations to act in the best interest of their
employer;

conduct will be assessed objectively. While subjective honest
may be relevant, "there is no haven for the morally
obtuse"; and

serious misconduct discovered after termination can be used to
justify summary dismissal and may result in the employer
justifiably withholding certain statutory and contractual
entitlements.

Clayton Utz communications are intended to provide
commentary and general information. They should not be relied upon
as legal advice. Formal legal advice should be sought in particular
transactions or on matters of interest arising from this bulletin.
Persons listed may not be admitted in all states and
territories.

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Valenzuela decision highlights that employers must seriously consider any potential dismissal based on serious misconduct.

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